Two new pages having particular relevance since the beginning of the most recent recession have been added to the DATABook-Houston beginning with February's issue. They are:

DATABook Pages 74 - ASSETS HELD BY ALL FEDERAL RESERVE BANKS

DataBook Pages 75 - EXCESS & REQUIRED RESERVES BY DEPOSITORY INSTITUTIONS

The chart on page 74 of the DATABook-Houston shows the changes in assets held by the Federal Reserve, which predominantly were U.S. Treasury securities prior to December 2007. At the beginning of the recession, the Fed began introducing new liquidity facilities, as indicated by the pink, dark purple and light blue areas on the chart. To remove the newly created reserves, between December 2007 and September 2008 the Fed "sterilized" the facilities by selling U.S. Treasury securities from its portfolio.

In the wake of the collapse of Lehman Brothers, the Fed began increasing its positions in liquidity facilities, but the size of the new programs eventually grew larger than the Fed's holding of treasuries. This effectively prevented sterilization through open market operations. As the size of the liquidity facilities continued to expand, the Fed issued new securities through its Supplementary Financing program that partially removed reserves from the banking system.

However, the Fed began significantly larger-scale purchases of assets in November 2008 and then began purchasing mortgage-backed securities and longer term Treasury debt in early 2009. At some point, the Fed will have to start liquidating all these assets, a process that may take up to five years, according to the president of the St. Louis Fed, James Bullard.

As can be seen in the chart on page 75, the most apparent result of purchasing those assets with hardly any sterilization was an unprecedented massive increase in excess reserves at depository institutions.

Prior to December 2007, excess reserves generally fluctuated around 4% above required reserves. By January 2009, excess reserves had increased from $1.88 billion in August 2008 to almost $900.00 billion. By February 2010 excess reserves peaked at over $1.16 trillion, but has since moderated at around $1.00 trillion. Note that changes in excess reserves almost are a mirror image of the increases in Fed purchases and are a liability to the Fed.

With such a large quantity of excess reserves and the money supply aggregate M2 growing at only 2.3% for all of 2010, it seems the traditional money multiplier is broken. In more "normal" times banks would not hoard such reserve balances, but would be making loans to its customers and accelerating the money supply.

One reason banks are not lending is that they are being paid interest on excess reserves (IOER) , currently at a rate of 0.25%. Some economists claim that the IOER is in effect a subsidy for not lending. Some call for the rate being cut to zero, while others have suggested that the Fed charge a penalty rate on excess reserves as Sweden's Riksbank does.

Another reason banks are reluctant to part with their excess reserves is the historically low level of interest rates they feel they can charge. While big corporations with quality credit typically are not seeking bank loans, given the political climate banks are uneasy charging what the market interest rate would be based on the underlying credit of small or mid-sized companies. With a much improved economy, interest rates gradually will increase and the quality of the credit for the latter firms will increase, making such loans more feasible.

It is our intent to include these two new charts in the DATABook-Houston as long as the Fed holds onto the unprecedented amounts of federal agency debt securities, mortgage-backed securities and other extraordinary assets, as well as the significant amount of excess reserves in the federal reserve system. Banks will start lending again, but not likely during 2011, and the level of excess reserves could prove to be inflationary in the long run.

It will be interesting to watch how the Fed attempts to unwind this abnormal bundle of assets and how the banking system will deplete its excess reserves. The Fed says it will act to make a smooth transition to normalcy without ramping up inflation or impeding employment growth. There is fear that the Fed's unwinding too rapidly could significantly affect the capital markets, increase overall interest rates and crowd-out private investment.

How long it will take to return the statistics in the two charts to levels they where at prior to the most current recession is at least five years. The U.S. economy will not return to a relative degree of normalcy until the level and composition of the Fed's assets, as well as the excess reserves at depository institutions, fall to where they were prior to the recession.